Central banks and other monetary authorities keep foreign exchange reserves (also known as international reserves) as assets in foreign currency, precious metals, special drawing rights and International Monetary Fund reserve positions.
These reserves are recorded in the balance of payments sub-financial account or foreign currency balance sheet of a single country or currency area.
The reserve match typically shows the country’s capacity to withstand some unexpected negative economic developments such as rising prices of raw materials or manufactured goods, credit crisis, natural disaster or sliding foreign trade, etc.
The history of currency reserves is closely linked to the development of the foreign exchange markets, and the connected monetary systems of the various countries. Currency reserves play a part in the shaping of monetary policy.
The central bank’s international reserve assets enable the reserve bank to buy the local currency, that is regarded as liability. Such measures assist in stabilizing the value of the local currency.
On December 31, 2008 the United States dollar accounted for 64.02% of foreign exchange reserves allocated in the world, and the euro 26.50%, by September 30, 2009 the U.S. dollar accounted for 61.64% and the euro 27.74%.
The global currency reserves have been on the rise in the recent years, at the beginning of 2003 they were about 2.3 trillion U.S. dollars, and by December 2007, they reached 6.561 trillion U.S. dollars. But experts say world currency reserves are rising much faster than the performance of the global economy, which in turn reflects on global inflation. Approximately two thirds of the reserves are held in Asian countries.
Foreign currency can be related to the monetary reserve fundamentally in three different exposures of a single country or economic region. And these include bank deposits, securities and other deposits with supranational institutions. The securitized money market investments outside their own currency area are mostly in the form of relatively secure bonds of foreign governments.
But increasingly through other interest-bearing investments in economies or countries in foreign currency, since a higher yield can be achieved. Also effective are the foreign exchange holdings of foreign notes and coins, the so-called varieties.
The amount of foreign exchange reserves is capable of easily shifting in tandem with monetary policy determinations. A reserve bank that applies a fixed exchange rate policy may find itself in a state of affairs with which supply and demand forces the value of the currency move lower or higher.